Exam 11: Aggregate Demand II: Applying the Is-Lm Model

The monetary transmission mechanism works through the effects of changes in the money supply on:

One policy response to the U.S. economic slowdown of 2001 were tax cuts. This policy response can be represented in the IS-LM model by shifting the curve to the .

Two identical countries, Alpha and Beta, can be described by the IS-LM model in the short run. The governments of both countries cut taxes by the same amount. The Central Bank of Alpha follows a policy of holding a constant money supply. The Central Bank of Beta follows a policy of holding a constant interest rate. Compare the impact of the tax cut on income and interest rates in the two countries.

The increase in income in response to a fiscal expansion in the IS-LM is:

In the IS-LM model when the Federal Reserve decreases the money supply, people bonds and the interest rate , leading to a(n) in investment and income.

The monetary transmission mechanism in the IS-LM model is a process whereby an increase in the money supply increases the demand for goods and services:

A decrease in government spending reduces output more in the Keynesian-cross model than in the IS-LM model. Explain why this is true.

Assume that an economy is described by the IS curve Y = 3,600 + 3G - 2T - 150r and the LM curve Y = 2 M/P + 100r [or r = 0.01Y - 0.02(M/P)]. The investment function for this economy is 1,000 - 50r. The consumption function is C = 200 + (2/3)(Y - T). Long-run equilibrium output for this economy is 4,000. The price level is 1.0 and M = 1,200. a. Assume that government spending is fixed at 1,200. The government wants to achieve a level of investment equal to 900 and also achieve Y = 4,000. What level of r is needed for I = 900? What levels of T and M must be set to achieve the two goals? What will be the levels of private saving, public saving, and national saving? (Hint: Check C + I + G = Y.) b. Now assume that the government wants to cut taxes to 1,000. With G set at 1,200, what will the interest rate be at Y = 4,000? What must be the value of M? What will I be? What will be the levels of private, public, and national saving? (Hint: Check C + I + G = Y.) c. Which set of policies may be referred to as tight fiscal, loose money? Which set of policies may be referred to as loose fiscal, tight money? Which "policy mix" most encourages investment?

Assume that the economy is initially in short-run equilibrium at a level of output above the natural rate. Use the IS-LM model to illustrate graphically how the levels of income and interest rates change as the economy returns to the natural rate of output in the long run.

When bond traders for the Federal Reserve seek to increase interest rates, they bonds, which shifts the curve to the left.

Use the IS-LM model to illustrate graphically the impact of the Pigou effect on the equilibrium level of income and interest rate during the Great Depression, when prices were falling.

If Congress passed a tax increase at the request of the president to reduce the budget deficit, but the Fed held the money supply constant, then the two policies together would generally lead to income and a interest rate.

An increase in consumer saving for any given level of income will shift the:

The LM curve can shift to the right if there is an increase in the supply of money or a fall in the price level. In which case is this movement along the aggregate demand curve and in which case is this a shift of the aggregate demand curve? Explain.

Compare the impact of a tax cut on consumption, investment, output, and interest rates in the classical model of Chapter 3 versus the IS-LM model.

An increase in the demand for money, at any given income level and level of interest rates, will, within the IS-LM framework, output and interest rates.

An economic change that does not shift the aggregate demand curve is a change in:

The aggregate demand curve generally slopes downward and to the right because, for any given money supply M a higher price level P causes a real money supply M/P, which the interest rate and spending.

In the IS-LM model, a decrease in government purchases leads to a(n) in planned expenditures, a(n) in total income, a(n) in money demand, and a(n) in the equilibrium interest rate.